How Finance Works: The HBR Guide to Thinking Smart About the Numbers

by Mihir Desai

that costs of capital are associated with the expected returns of capital providers.

those expected returns are dictated by the risk investors bear.

given investment, you need to figure out what the debt and equity providers demand and average those costs of d...

You tax-adjust them, because interest payments ar...

capital asset prici...

betas, rather

use the

WACC with care.

increase firm value by taking on more debt than the optimal capital structure.

Valuation is subjective, prone to error, and leads to ambiguous answers.

the process of valuation is as important as the end

point.

The two most important valuation methods are

multiples and discounted cash flows.

multiple is a ratio that compares the value of an asset to an operating metric associated with that asset.

lender who provides debt—

EV is the sum of the market value of debt and equity, or the value of the business.

many flaws.

comparability is not always so straightforward.

the payback period.

The payback method could lead you

to choose an investment because you get your money back faster, but turn away from an investment that creates much more value.

First, IRRs can give you the wrong answer because they’re focused on returns and not value creation.

cash flows are characterized by outflows, and then inflows and outflows again, and then inflows (as opposed to a simpler version using just outflows and then inflows), IRRs can give you wrong answers.

The discounted cash flow method is the gold standard of valuation.

are flows that assets generate that are truly free and truly cash.

“perpetuity formula”—a neat trick that effectively calculates today’s value for a stable set of cash flows.

Synergy is the idea that once merged, the value of two companies will be greater than the sum of the values of each individual company.

The problem with synergies is that people tend to overestimate how quickly those synergies will work and overestimate the magnitude of their effects. They ignore the fact that mergers are complicated and that changing cultures and changing workforces takes time.

related problem is that, even if the synergies are legitimate, people will often incorporate all those synergies into the price they pay for a company.

to understate the capital intensity of the business.

There are two major problems with using a price-to-earnings multiple to value Spirit.

First, earnings, as represented by net profit, are a problematic measure of economic performance,

The conclusion to the case resulted in Dell and Silver Lake paying the additional $4 to the shareholders.

Michael Dell’s incentives as both a seller and a buyer were not exactly clear;

the mechanics of cash distributions often lead people to fallacious arguments about value consequences associated with dilution or share counts.

returns to capital that exceed the costs of capital, reinvested profits for growth,

doing both for long periods of time.

lender identifies the cost of debt from a combination of the risk-free rate and a credit spread based on the riskiness of a company (it does not do this by multiplying the company’s current ratio by its credit rating).

the cost of equity is the risk-free rate, plus beta times the market risk premium.

capital asset pricing model, the cost of equity is the risk-free rate, plus beta times the market risk premium.

Higher betas, therefore, produce higher costs of

eq...

Positive NPV projects have returns greater than the cost of capital,

returns to capital greater than the cost of capital, reinvestment in growth,